Depending on your financial situation, one of the first things you may want to do when purchasing a new home is sign up for mortgage insurance, either through the private sector (called private mortgage insurance, PMI) or through the Federal Housing Administration (called FHA mortgage insurance). This is because almost all lenders require mortgage insurance for homebuyers who cannot make a large enough down payment, as a way of protecting the lenders against loan default.
Once you are settled into your home, however, one of the first things you will want to do is try to cancel your mortgage insurance. While for many, mortgage insurance is a necessary evil of homebuying, it is an extra premium you don’t want to be paying on top of your mortgage interest. Canceling mortgage insurance can take time and strategic planning, but there are several routes to achieving this goal.
One route is through your home appreciating in value. If your area suddenly becomes a more desirable real estate market within a few years of your moving in, and your home gains in value by 10%, you are that much closer to reaching the 20% stake in your home that you will need to have for your lender to cancel your mortgage insurance. (If you are able to pay this 20% up front, you will not need to pay mortgage insurance in the first place.)
Home improvements that you invest in ― such as upgrading a kitchen or adding a garage ― will also increase your home’s value. Of course, you will need to get your home officially appraised in order to satisfy your lender that your home equity level has reached 20%. It’s important to weigh the cost of this appraisal against your mortgage insurance premium savings and your current budget.
Another way to cancel mortgage insurance is simply to pay your mortgage down until your remaining balance, combined with your initial down payment, is less than 80% of the home’s value. Mortgage lenders, as per the Homeowners Protection Act of 1998, are required to automatically cancel your mortgage insurance once you have reached 20% equity in your home.
Most lenders will agree to cancel mortgage insurance once you have reached 20%, however, as long as you have been current with your mortgage payments and are not considered a high risk. Keep in mind that during the first few years of a 30-year mortgage, the majority of your payments go towards interest and not toward paying off your principal balance, so you should plan accordingly.